a) If Fed wants to keep real GDP at its potential level in 2011 should it use expansionary policy or a contractionary policy? Should Fed NY sell or buy Tâ?bills? How about Fed Dallas and Fed Philadelphia, are they expected to sell or buy Tâ?bills?

b) If the Fedâ??s policy in keeping real GDP at its potential in 2011, state whether each of the following will be higher, lower, or the same as it would have been if the Fed had taken no action:
1. Real GDP;
2. Potential GDP;
3. The inflation rate;
4. The unemployment rate

c) Draw an aggregate demand and aggregate supply graph to illustrate your answer. Be sure that your graph contains LRAS curves for 2010 and 2011; SRAS curves for 2010 and 2011; AD curves for 2010 and 2011, with and without monetary policy action; and equilibrium real GDP and price level in 2011 with and without policy.

Solution Preview

Notice that potential real GDP is lower than real GDP in 2011. This means that the Fed needs to slow down the economy, or use contractionary monetary policy. It will need to sell T bills, which reduces currency in circulation. All branches of the Fed ...